PDVSA, some history, some personal views

31.05.05 | Last week, in the testimony of the Minister of Energy there was a phrase that criticized the fact that in the old PDVSA the objective was to maximize the value of the company to the shareholder which is the State, rather than maximizing the value of the natural resource for the same State.

I have pondered about that sentence over and over in the last few days, but to tell you the truth, I am not sure that there really is a difference between the two. In fact, the first statement is much clearer and well defined to me than the second. There are three contributions to the Government by the production of oil. The first is the royalty; every barrel exported pays a royalty tax directly to the Government, which depends on the type of oil. Later, PDVSA pays taxes on the earnings it has for the year based on quaterly estimates and pays it also pays dividends to the owner, which is also the State. I am sure you could write a complicated algorithm that would tell you how to maximize the total, but the business is more complicated than that and I think the Minister’s words are very empty, they are simply political rhetoric.

The PDVSA strategy, circa 1997-1998

The PDVSA strategy that was being carried out in the mid 90’s has to be understood in its context: PDVSA wanted to maximize its earnings (and thus contributions to the State), given its finite resources for investment purposes. It could have decided to leave things as they were, continue producing what it was producing with its own investment capabilities. This was the lowest return path for the Government and for the company. Why? Because PDVSA was exploiting a large number of old fields that needed heavy investments to keep them going, but were fields past their peak production levels. The margin for exploiting those fields was much lower than for the newer fields. This implied lower profits and thus lower earnings, lower taxes and lower dividends for the Government. All of this for the same level of investment.

The oil opening, the “Apertura”

This was the origin of the oil opening: Take those fields; sell the right to exploit them at a price to mostly foreign or Venezuelan companies, which paid over US$ 2 billion in the 1997 round of the opening. If it was such a sweet deal, how come some fields received no bids in the public auction? Even more interesting is that these payments seem to have been forgotten.

Of course, this presupposes that the strategy that the PDVSA Board had at the time of producing six million barrels of oil a day was “correct”. At the time, Chavez and his supporters were highly critical of it, but the latest plan by PDVSA is to produce 5 million barrels, so you can not say that one or the other was trying to get the highest price for the natural resource for the shareholder.

In fact, what about giving away gasoline in Venezuela? Gasoline is currently 20 cents a gallon, what right do current Venezuelans have over future generations to waste away gasoline at these prices?

As usual I digress.

With the oil opening, the Government gets the same amount in royalties, PDVSA does not have to invest any of its own funds and the company that bought the rights has to pay taxes on its profits. Yes, the Government gets fewer dividends, but in theory, it gets more dividends and more profits because it is investing those funds elsewhere, in more profitable, higher margin projects. Notice that I said “in theory”, because such investments are not being done today.

The oil partnerships

The oil partnerships in the Orinoco heavy crude belt are a totally different strategy. At the time, the question was, Venezuela has some gizillion barrels of heavy oil in the Orinoco Oil Belt, can we get any of it out and make a profit?

Recall that oil was at $15 per barrel of WTI, when this question was being posed. What was proposed then, was to upgrade these heavy crudes to make synthetic fuels. There was only one country in the world which was offering similar projects, Canada, which was charging 1% royalties until a certain benchmark in production was reached. Venezuela offered a similar deal for partnerships with PDVSA itself. This is where Sincor, Cerro Negro, Petrozuata and Hamaca were born.

These deals were funded with either publicly traded bonds or bank loans. The owners of the projects were forced to offer a guarantee for the bonds until the projects reached certain production benchmarks. Moreover, all of the bonds were “sinking fund” whereby bondholders are paid part of the capital partially at the same time they get the interest. In this way, part of the risk gets diluted with the passage of time.

Why all the complication? Easy, the price of oil was low, the projects had not been proven, and not everyone was convinced they would make money. It was not high tech, but it was not “proven tech” either. Even today, with WTI at US$ 50, the bonds for most of these projects which mature in 2009 offer a yield to maturity of 8%. Obviously they are not as risk free as the Government makes it look (Although the Government itself is now creating part of the risk with rules changes and noise).

Perhaps somebody should have thought then about a sliding royalty. (I haven’t heard anyone mention it now either, it is just a thought I have had). Maybe it would have made more sense to say, the partnerships will pay 1% for x years, after that 16.6% over the first billion dollars of production per year, 30% over the next half billion and son on and so forth. Nobody imagined oil prices would get this high. Nobody proposed a sliding scale, nobody has. All we have is these accusations and unilateral decisions.

Conclusions

In the end, I think that PDVSA’s purpose should be to maximize profit and dividends for the shareholders (The “people”!). PDVSA should also be a motor of growth for the country. To do that it has to establish an adequate level of borrowing and devote that to those projects with the highest profit margins. Lower margin projects should be sold to the highest bidder, if it is in the interest of the country. Heavy oil projects should be promoted given that the country has such ample reserves.

What does not make sense is to have a company with US$ 40 billion in sales have almost zero debt if such debt can help the company increase both profits and revenues. PDVSA has less than US$ 100 million in debt, zero for all practical purposes. This is certainly without justification.

PDVSA should also not cancel existing projects because the profits are small, such as Orimulsion, for such projects already exist. If they create substantial amount of jobs. Who cares?

In the end, the starndard of living of a large fraction of Venezuelans will not improve until there is real sustained growth in the economy. PDVSA is a perfect engine for such growth, but is not being used that way. It may sound really “neat” to have PDVSA give all the funds to social programs, but if doing that is simply taking capital away from the company you are simply killing the golden goose in the long run. In the end, seeing PDVSA as a commercial enterprise tells you exactly what you can or can not do, what you should and should not do. It can be run as a not for profit organization, giving away all of its profits, but it can not be run as a “for loss” organization, because it does not make sense to give to the Venezuelans of today, taking away from those of the next generations.

In the end, I still don’t know what “maximizing the value of the natural resource” means. It could mean increasing the price of gasoline. It could mean producing less oil to save for the future at higher prices, something this Government claims not to be doing, and it could mean only producing a certain type of project, something which is not happening. I still think PDVSA should maximize royalties and profits (And thus taxes and dividends). I can’t think of any other strategy that may benefit the average Venezuelan. The rest is simple rhetoric.